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An Update/Reminder on Rent Inflation
A subscriber to our Quarterly Inflation Outlook (you can subscribe here) wrote to me recently and asked about a research piece put out by a major sell-side investment house that discussed how private rental indices (such as Zillow) and the Fed’s NTRR (“New Tenant Rent Index”, as defined in a paper by the Cleveland Fed’s Randall Verbrugge a couple of years ago called “Disentangling Rent Index Differences: Data, Methods, and Scope”) were indicating that a decline in rent inflation was on the way. I felt like it was time for an update on this topic, since it has been a little while since the exact same arguments made the rounds a few years ago.
I even had a podcast (Ep. 74: Inflation Folk Remedies) in July 2023 in which I discussed (among other things) the NTRR issue. So the deceleration of Zillow and the other private rent indices, the NTRR which was forecasting sharply negative rent growth (before revisions!), the supply of new rental units – all of those are arguments from 2023!
Here are rents. The black line is the actual CPI for Primary Rents, y/y. In July of 2023, it was at 8%. You may notice that it never went negative in 2023 or 2024, and isn’t showing any signs of going negative in 2025.
Before I go any further, here is sufficient reason to ignore the NTRR, in addition to the other arguments I’ll make in a bit. Here is the chart of the NTRR from the 2023 paper.
And here is the updated NTRR from Bloomberg today. You will note that the 0% print in 2023Q1 from the 2023 paper has been revised up to around 4.5%. That’s even higher than the upper edge of the error range in the prior chart.
So forgive me if I don’t panic at the -2.2% current reading of the NTRR. Here’s the problem: the conviction among economists in 2023 (not just the Fed economists, but it was a general consensus at the time that rents were about to collapse) that the “stock” of rent inflation would eventually respond to the “flow” of new rents is just not how rents work. The new rents are not indicative of new conditions while the stock isn’t…those are two totally different populations.
There are people who turn over rents and move with some frequency, or who are moving now for one reason or another, and there is a stock of open units that landlords want to fill. But just because a landlord offers a low rent to fill his one open unit has nothing to do with his desire to cut rents on all of the units that aren’t turning over.
What is amazing is that the only reason this ever looked like it worked was because when both rates are very low, the noise outweighs the signal. So there’s no data for economists to really test the hypothesis on a period that matters because it’s similar to the current period of generally rising prices. But if economists just spoke to landlords, they would understand. That’s what I did, and the reason that in 2023 I switched my model from a top-down to a bottom-up (which is the dotted line in the first chart above…and that was not revised significantly). If costs are growing for landlords, they aren’t going to be cutting rents for their tenants even if they want to cut them for new tenants to fill a unit.
It should not be a surprise that the ‘faster’ NTRR has large error bars and large revisions. Essentially, the idea behind those indices is that they take the same rent data the BLS generates and squeeze out several different indices, some of which are “faster.” But basic information theory says you can’t get 3 bits of data from a pile that holds 1 bit, for free. What happens is those new indices are faster…but they have huge error bars that are huger the shorter the forecast length. Duh. Which means you can’t reject any null hypothesis about the near-term path. In the original paper they mention this and they show the data on the variance but they didn’t really explain it well. The short way to describe the problem is that you can’t get three pounds of crap out of a one pound bag. Period.
Now…having said all that I do entertain the possibility that rents could slow meaningfully further than here, even more than the mild softening that my model has. But my reasons for that are different:
- Rents in NYC will likely decline sharply if Mamdani wins, partly because jobs will absolutely flee the city but mainly because of his not-very-veiled-threat to seize property if they don’t. The smart landlords will dump their property at any price and get out, but some will try to ride out his term as Mayor. That’s unlikely to work but they’ll try. And NYC is a big part of the rent indices (by the way, one hedge for this is to sell the Shiller NYC property index, which futures trade (thinly, but they trade) on the CME. Combined with naturally slowing rent growth from some of the really hot but now getting overbuilt areas – like Miami – and you could get the overall indices to look better than the median would.
- (Offsetting this but probably nearer-term, LA rents will be buoyant for a while and maybe more sharply once the wildfires are further in the rear-view mirror so the claims of “profiteering” can be ignored. They bounced right after the fires destroyed a huge number of units but predictably people screamed at landlords so that stopped. But supply and demand, you know. There are fewer rental units in Los Angeles, and rents are going to go up faster as a result).
- If mass deportations really do turn into mass deportations, then what we are already seeing with Lodging Away from Home could become broader pressure on rents. The hotels were where the newest and biggest wave of illegal migrants were housed in the big cities. Elsewhere, they live in apartments and sometimes own homes when they have been here for a while. I can’t imagine the government will be able to deport more than say 1mm over the next year or two. That would be 2000-4000 per work day, and while the illegal immigrants generally walked in they generally have to be flown out. However, 1mm is still a big number and if enough other illegals ‘self-deported’ so that you’re talking about a million households then you’d have to consider a good chance of significant housing disinflation as the stock of rental units – currently just barely out of shortage – becomes a glut from the demand side.
But note that neither 1 nor 2 is currently something that you’d be able to detect with NTRR or Zillow or other rental indices. Maybe at the margin we could see deportations affecting rents in some of the ‘sanctuary cities’ where a lot of the deportations are concentrated, but I doubt it. Too soon.
In any event, my forecast for rents is not super-aggressive and I recognize there are mostly downside risks associated with those enumerated reasons. But right now? In the data? There is nothing that looks like it spells housing deflation.
“Why Aren’t Home Prices Falling?”
From time to time, I like to point out errors that we make because we think in nominal space, or because we had 25 years of inflation being so low that we didn’t have to think about it very much. I do think that at some level, we should consider pointing the finger at economics education, which teaches static equilibria until you get into fairly advanced (graduate level) classes – and even then, generally in nominal terms.
There’s a very good videocast that I like to check in with occasionally, by Altos Research, which runs through recent data on home buying trends along with useful commentary. It tends to be more thoughtful and to not fall victim to the wild swings of emotion that seem to affect a lot of housing market observers. I think it’s important for me to say that I like this channel, since I’m about to criticize an episode they recently put out.
It was called ‘Why Aren’t Home Prices Falling?’ and you can find the quick 15-minute video here: https://www.youtube.com/watch?v=J-0bkqeFZEE. You can get a good feel for the videocast, and the useful analysis they bring, from this episode.
But the question ‘why aren’t home prices falling?’ is an odd one. Median CPI is still running at 4.2% y/y. Sticky CPI is +4.1%. Apartment rents are +5.0% and never declined y/y, even when there was a rent moratorium. Asset prices in general are quite a bit higher over the last few years also, so whether you’re looking at homes from the standpoint of an investment or a consumption item, it’s hard to see why one would naturally default to ‘home prices should be falling.’
The thought process is that ‘home prices went up so much, no one can afford them! Therefore, prices should fall.’ This thought process does not originate with Altos; they are just trying to answer the question being asked. In my view, though, they aren’t answering the right question. Really, when you think about it, the whole framing of the question evokes Yogi Berra saying that ‘no one goes to that club any more because it’s too crowded.’ Home prices going up a lot is a pretty serious piece of evidence that supply and demand has previously cleared at a price that (it is assumed) is too high for people to afford. That should sound odd.
The thought process goes further by noting that the volume of transactions has really declined markedly over the last couple of years, thanks to high interest rates keeping supply off the market as homeowners with current low interest rates locked in recognize that buying a new home would involve an effective refinancing to more expensive money. But if that restriction in supply is the main reason that home prices didn’t decline, then why have home prices in Australia and the UK also generally been rising, except for a dip around the same time that we had a dip in the US? Australian mortgages are normally floating-rate, and in the UK a 5-year fixed rate is the standard. But the low y/y change in Australia (according to the Dallas Fed’s index of Australian home prices – don’t ask me why they track Australian home prices) in 2023 was -4.3% (now +7.7%), the low in the UK was -2.5% (now +2.2%), and the low in the US was -3.4% (now +2.9%, using Existing Home Sales Median y/y). All of those markets saw very large rises, small and brief declines, and are now rising again.
These are very different property markets, very different mortgage markets, very different governments, taxation regimes, populations, and yet they have strikingly similar patterns of home price changes in a market that classically is all about ‘location, location, location.’ This should lead the thoughtful analyst to think that there’s something else going on.
The something else – not to beat a dead horse again – is the change in the quantity of money, which has followed a very similar pattern in every major economy in the years after 2019. And this is where conventional Economics education falls short. Here is a chart of the y/y changes in US M2, alongside the y/y change in Existing Home Median sales prices.
Not all of the price changes you are seeing in homes is a ‘real’ price change. Much of what you are seeing is a change not in the value of a home, but in the value of the currency unit relative to durable physical assets. But in Econ 101, they’d tell you that you should look at changes in supply and demand, and that will predict changes in the price and quantity at which the market clears. In that narrow frame, you might look at the large increase in home prices and attribute it to changes in demand due to declining interest rates, although you’d be confused when the massive increase in interest rates caused only a modest and temporary drop in nominal home prices. (In late 2022, the Case-Shiller futures for end-of-2023 were pricing in a 19% decline in nominal prices with inflation at a positive 3-5% per year, implying an unprecedented collapse in real prices).[1]
Obviously, that frame doesn’t make sense when the underlying price level is rapidly changing, and the underlying quantity of money is rapidly changing. This is often more obvious when we make it extreme. Suppose the money supply went up 400%, and prices quintupled as well, and interest rates went to 100%. Would you expect home prices to decline in nominal terms? That would be absurd – the price level going up by a factor of 5 means that the value of the measuring stick is what is changing. And remember, it is entirely consistent to have the volume of transactions decline sharply while the nominal price increases. Homebuilders care about the volume of transactions; homebuyers care about the price. You may be absolutely bearish on homebuilders, while still expecting home prices to increase, especially if the price level is increasing.
That’s exactly what we have been experiencing. And, with the money supply growing again and median prices still rising at 4% per year, it does not seem to me that there is any natural reason to expect home prices to decline. So the short answer to the question ‘Why Aren’t Home Prices Falling?’ is ‘There’s no reason they should.’
[1] Markets are where risk clears, not where investors ‘expect’ prices to be, and there were wonderful gains to be made even well into 2023 by helping the nervous real estate longs clear their risk. https://inflationguy.blog/2023/08/29/home-price-futures-curve-still-looks-weird/
